How to Create a Cash Flow Statement for a Startup

A profitable startup can still be weeks away from insolvency. This isn't a paradox; it's a cash flow problem that many founders learn the hard way. Unlike the income statement, which shows profitability on an accrual basis, the statement of cash flows gives you a brutally honest look at the cash moving in and out of your business. This tutorial provides a step-by-step guide to creating an accurate cash flow statement, so you can understand your startup’s financial health and make smarter decisions.

Why a Cash Flow Statement is a Startup’s Best Friend

For a startup, cash isn't just king—it's the entire kingdom. The statement of cash flows is less about proving profitability and more about tracking survival. It reveals your burn rate, measures runway, and shows how effectively you’re converting investment capital into operational motion. For instance, you could land a massive contract and record a huge jump in net income, but if the client has 90-day payment terms, you won't see that cash for three months. That gap between recorded revenue and actual cash in the bank can sink an otherwise healthy business.

Investors pay close attention to this document. A predictable cash burn signals disciplined operations, while erratic cash flow may suggest a lack of foresight or poor management of working capital. For founders and their finance teams, it's a vital tool for planning when to hire, whether you can afford that new equipment, and, most importantly, when you might need to raise your next round of funding.

Gathering Your Financial Data

Before you begin constructing the statement, you need three key financial documents. Having these accurate and ready will make the process significantly smoother. Modern cloud accounting platforms like QuickBooks Online, Xero, or Wave are designed to generate these reports directly, saving considerable manual effort.

• Comparative Balance Sheets: You need two balance sheets—one from the beginning of your chosen period (e.g., January 1) and one from the end (e.g., March 31 for a quarterly statement). This comparison shows how your assets, liabilities, and equity have changed over time.
• Income Statement: Your income statement for the period in question (e.g., Q1) provides the Net Income, which will be the starting point for the most common preparation method.
• General Ledger: While not always necessary for a high-level statement, having access to the ledger can help you investigate large or unusual transactions, especially within investing and financing activities (like the purchase of property or the issuance of stock).

Understanding the Three Core Components

A statement of cash flows is always organized into the same three sections. Understanding what each section represents is fundamental to both its creation and its interpretation.

1. Cash from Operating Activities (CFO): This is the cash generated by your startup's core business activities. It includes the cash received from customers and the cash paid to suppliers, employees, for rent, and other operational expenses. A positive and growing CFO indicates a healthy business model that can sustain itself without constantly relying on outside funding. For startups, this number is often negative in the early days, but tracking its trend toward positive is a key performance indicator.

2. Cash from Investing Activities (CFI): This section covers cash used for or generated from the purchase and sale of long-term assets. For a startup, this typically means cash outflows to buy computers, equipment, furniture, or intellectual property. If you sell off any of these assets, the cash received would show up here as an inflow. Significant investments in assets often signal a period of growth and expansion.

3. Cash from Financing Activities (CFF): This shows how your startup is funded. It includes cash received from investors when you issue stock, funds from bank loans, and contributions from owners. On the outflow side, it includes principal repayments on debt and payments of dividends. For VC-backed startups, this section will light up with large cash inflows after a funding round closes.

Choosing Your Method: Indirect vs. Direct

There are two accepted ways to prepare the cash flow statement: the indirect method and the direct method. While both arrive at the same final number for total cash flow, they present the Operating Activities section very differently.

• The Indirect Method is used by over 98% of public companies because it’s simpler to compile from standard financial statements. It begins with your Net Income from the income statement and then adjusts it for non-cash expenses (like depreciation) and changes in working capital (like an increase in accounts receivable). Its strength is that it clearly shows the reconciliation between your net income and your actual cash flow from operations, highlighting why "profit" and "cash" are not the same thing.
• The Direct Method is more intuitive in theory. It presents the actual cash inflows and outflows directly—for example, "Cash collected from customers" and "Cash paid to suppliers." While clearer for an operational manager, it's far more difficult to prepare. You have to analyze every transaction in your bank account and classify it, a time-consuming process that most accounting software isn't optimized for. Further, accounting rules require that if you use the direct method, you must *also* provide the reconciliation found in the indirect method, creating redundant work. For these reasons, we will focus on the more practical indirect method below.

Step-by-Step Guide: Creating a Cash Flow Statement (Indirect Method)

Let's walk through building your statement, starting with a hypothetical net income of $20,000 for the quarter.

Step 1: Start with Net Income

This is the easy part. Pull the net income figure directly from the bottom of your income statement for the period. Let's use $20,000.

Step 2: Add Back Non-Cash Expenses

Your income statement includes several expenses that don't actually reduce your cash balance. You need to add these back to your net income. The two most common for a startup are:

• Depreciation and Amortization: If you bought $12,000 worth of laptops expected to last 3 years, you might record $1,000 of depreciation expense per quarter. This reduces your net income, but no cash leaves your account. Add it back.
• Stock-Based Compensation: If you grant employees stock options as part of their pay, you must recognize this as an expense. It reduces net income without a corresponding cash outflow. This must also be added back.

Let’s assume you had $1,000 in depreciation. Your subtotal is now $20,000 + $1,000 = $21,000.

Step 3: Factor in Changes in Working Capital

This is where the comparative balance sheets become necessary. Working capital refers to your current operating assets and liabilities. The key is to remember how a change in each affects your cash.

• Changes in Current Assets (e.g., Accounts Receivable, Inventory):
  • An increase in an asset is a use of cash (e.g., more money got tied up in receivables), so you subtract the change.
  • A decrease in an asset is a source of cash (e.g., a customer paid an old invoice), so you add the change.
• Changes in Current Liabilities (e.g., Accounts Payable, Accrued Expenses):
  • An increase in a liability is a source of cash (e.g., you held off on paying a supplier), so you add the change.
  • A decrease in a liability is a use of cash (e.g., you paid down a bill), so you subtract the change.

Imagine your Accounts Receivable grew by $5,000 and your Accounts Payable grew by $2,000. Your adjustment would be -$5,000 and +$2,000. Your ongoing calculation for operating cash flow is $21,000 - $5,000 + $2,000 = $18,000 (Cash from Operations).

Step 4: Calculate Cash Flow from Investing Activities

Now, look at the long-term asset section of your balance sheet. Did you buy any property, plant, or equipment (PP&E)? Let's say your PP&E account increased by $10,000 because you bought new office furniture. That's a $10,000 use of cash. So, your Cash from Investing = -$10,000.

Step 5: Calculate Cash Flow from Financing Activities

Finally, examine changes in long-term debt and equity. Did you take out a loan, or did an investor put in money? Let's say you closed a seed round and issued $100,000 in stock while also repaying $5,000 of a business loan. Your net financing cash flow would be +$100,000 - $5,000 = $95,000 (Cash from Financing).

Step 6: Put It All Together and Reconcile

Now you sum the three sections to find the total change in cash for the period:

Net Change in Cash = CFO ($18,000) + CFI (-$10,000) + CFF ($95,000) = $103,000

To confirm your work, this result should match the change in your cash balance on the balance sheet. If your Cash at the start of the period was $50,000, your ending cash should be $50,000 + $103,000 = $153,000. If this number matches the cash balance on your period-end balance sheet, you’ve done it correctly.

Common Startup Pitfalls

When preparing this statement, early-stage companies often run into a few common issues that can distort their financial picture:

• Co-mingling Funds: The founder paying for a business expense with a personal credit card (or vice versa) is a bookkeeping nightmare. It muddies the waters when trying to isolate true business cash flows.
• Forgetting Non-Cash Financing/Investing: If you acquire equipment in exchange for company stock, no cash ever changes hands, but it’s a significant transaction. This sort of activity should be listed in the footnotes of your financial statements.
• Misclassifying Interest and Taxes: Generally, cash paid for interest and income taxes are classified under Operating Activities. Ensure these aren't accidentally swept into other categories.

Final Thoughts

Creating your first statement of cash flows demystifies where your money is truly going. It transforms foggy financial questions into concrete numbers, providing the clarity needed to manage runways, secure investor confidence, and steer your business toward a stable financial future. For any founder or adviser, it's an indispensable report.

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